Reducing Down Payments to 3 Percent Is a Bad Idea

After the crash of the American housing market in 2007, the news was full of talk of “subprime mortgages” — that is, mortgages belonging to those with poor credit ratings. Why were subprime mortgages to blame? Misguided federal policy, say Columbia University Professor Charles Calomiris and Hoover Institution Senior Fellow Stephen Haber.

Writing for Economics21, Calomiris and Haber explain what happened in the mortgage market. The federal government wanted to make housing more affordable for low-income Americans. So, the government encouraged banks to give loans to low-income borrowers, and Fannie Mae and Freddie Mac — government-sponsored enterprises that purchase and sell mortgages — purchased those loans. A host of bad mortgages were issued, as individuals were required to put little money down and provide scant information concerning their employment and incomes.

Did this [redistribution] policy improve the economic situation for low-income Americans? Not at all. As Calomiris and Haber explain, low- and middle-income borrowers with huge mortgage debts lost their homes to foreclosure when the housing market collapsed.

Prior to the 1990s, a 20 percent down payment for a Fannie or Freddie housing loan was standard, but at the start of the subprime mortgage crisis, required down payments had fallen dramatically — over one-quarter (26 percent) of Fannie Mae loans and 19 percent of Freddie Mac loans had down payments under 5 percent, according to Paul Sperry at the New York Post.

In December, the government announced that it was reducing the minimum down payment for Fannie Mae and Freddie Mac mortgages to a meager 3 percent in order to combat inequality, which Calomiris and Haber say is a bad idea, pointing to what happened just a few years ago. What would be a better solution? Improved competition among banks, which the authors say “promotes credit growth in a way that tends to reduce inequality,” rather than the opposite.

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